Stress test

 Every year the biggest U.S. banks endure a tedious exercise, where their businesses are put through a series of theoretical contortions to see how they’d perform in a crisis. One flaw in this plan is that the Federal Reserve, which designs the stress test, has tended to assume that when bad times come, interest rates would fall, not rise. This misconception was corrected by the market, which just staged an exam of its own.

An unanswered question is what rising rates will do to borrowers, and the economy more broadly. Office towers, shopping malls, warehouses and other commercial real estate are a worry. Morgan Stanley’s (MS.N) investment bank wrote off $70 million of debt in the last quarter, centered on its holdings of such property. 

It’s a drop in a bucket that holds $223 billion of loans, but it’s also a reminder that it’s hard to see from the outside where these risks will surface.

https://www.reuters.com/breakingviews/wall-street-aces-its-real-life-stress-test-2023-04-20/

Fed has now made a supervisory error of monumental proportions:

It fixated on large banks and overlooked smaller regional banks like SVB, Signature, and First Republic, where accidents were waiting to happen.

In its February 2023 stress test, the Fed conceded that it needed to start thinking more broadly about different shocks, and it allowed for the possibility of a new “exploratory market shock” – still a recession, albeit one accompanied by higher inflation. 

https://englundmacro.blogspot.com/2023/03/the-failure-of-svb-is-symptomatic-of.html